915 F.

2d 832
66 A.F.T.R.2d 90-5685, 90-2 USTC P 50,532

Harvey JACOBSON and Marcia Jacobson, PetitionersAppellants,

v.
COMMISSIONER OF INTERNAL REVENUE, DefendantAppellee.
No. 155, Docket 89-4057.

United States Court of Appeals,

Second Circuit.
Argued Oct. 6, 1989.
Decided Oct. 5, 1990.

Walter J. Rockler, Washington, D.C. (Richard L. Hubbard, Arnold &

Porter, Washington, D.C., of counsel), for petitioners-appellants.
Charles Bricken, Atty., Tax Div., Dept. of Justice, Washington, D.C.
(Shirley D. Peterson, Asst. Atty. Gen., Gary R. Allen, David English
Carmack, Attys., Tax Div., Dept. of Justice, Washington, D.C., of
counsel), for defendant-appellee.
Before NEWMAN, PRATT and MAHONEY, Circuit Judges.
MAHONEY, Circuit Judge:

Harvey and Marcia Jacobson1 appeal from an order and decision of the United
States Tax Court, B. John Williams, Jr., Judge, entered February 2, 1989 that
determined (1) a federal income tax deficiency for 1979 in the amount of
$29,444, and (2) that the entire deficiency constituted a substantial
underpayment attributable to a tax-motivated transaction for purposes of
computing the interest payable with respect to the deficiency, pursuant to 26
U.S.C. Sec. 6621(c) (1988), formerly Sec. 6621(d).2 The memorandum opinion
of the Tax Court is reported as Jacobson v. Commissioner, 55 T.C.M. (CCH)
1437 (1988).

The Tax Court, substantially upholding an assessment by the Commissioner of

Internal Revenue (the "Commissioner"),3 found that the acquisition of the
motion picture Promises in the Dark ("Promises ") by Triad Associates
("Triad"), a limited partnership, was devoid of economic substance and should
be ignored for federal income tax purposes. The court accordingly disallowed a
loss of $57,125 shown on Jacobson's 1979 tax return as his distributive share of
Triad's 1979 tax loss, and an investment tax credit of $3,198 attributable to
Jacobson's interest in Triad.

We reverse and remand.

Background
4

In October 1979, Jacobson acquired one-third of a unit of Triad, representing a

1.58333 percent interest in the profits and losses of Triad. The purchase price
was $37,334.45. $9,733.63 was paid in cash, and the remainder was in the form
of two promissory notes, one in the amount of $20,755.16 due March 15, 1980
and one in the amount of $6,845.66 due January 15, 1981, both secured by an
irrevocable letter of credit dated October 31, 1979.

Triad was a New York limited partnership formed on August 13, 1979 to
acquire, own and exploit motion pictures. Promises was the only film acquired,
although it was originally intended that Triad acquire two additional films,
Heartbeat and Ten. Triad's two general partners were Daniel Glass and
Seymour Malamed, both of whom had significant experience in the motion
picture industry and in organizing limited partnerships to acquire and distribute
films.

Glass was an attorney who had practiced for over thirty years in the
entertainment industry, particularly in motion pictures and television. He had
been general counsel and business manager of Screen Gems, Inc., a subsidiary
of Columbia Pictures, and was responsible for negotiating movie distribution
and purchase agreements. Malamed had been a consultant to the movie industry
since 1975, and for twenty years prior thereto was an officer of Columbia
Pictures, where his positions included the following: executive vice presidentadministration, 1973-1975; vice president-finance, treasurer, and chief
administrative officer, 1971-1973; vice president, treasurer, and chief financial
officer, 1963-1971. In the five years preceding the transaction at issue herein,
both had acted as general partners of other partnerships which had financed the
production of, or purchased, numerous motion pictures, many of which had
been commercially successful.

Orion Pictures Company ("Orion") owned Promises, a completed motion

picture. Promises featured actress Marsha Mason, whose starring role in The
Goodbye Girl resulted in an Academy Award nomination. Promises was
directed by a successful producer, Jerome Hellman, and the screenplay was
written by Loring Mandel, a well known script writer who had won an Emmy
Award. The film was described in one of Triad's offering documents as follows:

The picture is set in a middle sized town in Connecticut and depicts the effect
on a young doctor (Marsha Mason) of the terminal illness of a teenage girl
patient and the relationship of the doctor with her hospital colleagues as well as
the relationship of both doctor and patient with the girl's family and friends,
involving all of the emotional conflicts and moral dilemmas in such a situation.

Glass and Malamed viewed Promises, and decided that Triad would purchase
the film from Orion.

10

Triad simultaneously entered into two agreements with Orion, a Purchase

Agreement and a Distribution Agreement, as of October 1, 1979. In the
Purchase Agreement, Orion sold Promises to Triad, retaining certain rights,4 for
$6,130,000. The purchase price was based upon the actual production costs of
the film, which were warranted by Warner Brothers, Inc. ("Warner Brothers"),
successor to Orion as distributor of the film, and Orion to be $6,284,842. Of
this amount, Triad was to pay $380,000 at closing, with the balance in the form
of two nonnegotiable promissory notes: a full recourse note in the amount of
$2,650,000 (the "Recourse Note") and a nonrecourse note in the amount of
$3,100,000 (the "Nonrecourse Note"). Both notes were payable on September
30, 1986, bore interest at 6% per annum, and were secured by a lien on
Promises.

11

Interest on both notes, and the principal amount of the Nonrecourse Note, were
to be paid solely out of receipts resulting from the distribution of Promises.
Each limited partner of Triad assumed primary liability for that partner's pro
rata share of the principal of the Recourse Note.

12

The Distribution Agreement conveyed from Triad back to Orion "all

advertising, distribution, exhibition and exploitation rights and licenses" in
Promises. Triad undertook to advance to Orion the first $1,800,000 of
advertising costs for the film, and to pay Orion a marketing strategy fee in the
amount of $1,200,000. These amounts were to be recouped from the proceeds
of the distribution of Promises, in accordance with a complicated formula set
forth in Exhibit A to the Distribution Agreement.

13

Exhibit A to the Distribution Agreement also provided that Triad would be

entitled to be paid from Promises' television receipts "an amount equal to the
unpaid principal amount of the Recourse note when due (whether upon
maturity or by way of acceleration) after application of all other proceeds
remitted or remittable to [Triad] and applied in reduction of the principal
amount of said Recourse Note." The television receipts payable to Triad were
those remaining after payment of Orion's distribution fee, which was
contractually defined as twenty-five percent for a sale or license for free
television reception on a national network, subject to downward and upward
adjustments depending upon the timing of the fee in relation to total gross
receipts generated by Promises.5

14

In order to finance the $1,800,000 advertising advance and $1,200,000

marketing strategy fee, respectively, Triad obtained a "Marketing Loan" in the
amount of $1,850,000 and an "Additional Financing Loan" in the amount of
$1,656,080 from Chemical Bank. The Marketing Loan was a nonrecourse
obligation, with principal and interest to be satisfied solely out of Triad's right
to receipts from the commercial exploitation of Promises. If those receipts were
inadequate to meet any interest payment, Orion was to advance the difference to
Chemical Bank, and was entitled to recoup any such advance from future
receipts generated by Promises.

15

The Additional Financing Loan, on the other hand, was a recourse obligation as
to which each limited partner of Triad was personally obligated for his
proportionate share of the principal amount. As security for payment, Triad
pledged to Chemical Bank the letters of credit and certificates of deposit that
Triad had received as security for payment of the limited partners' capital
contributions.

16

Since Triad would recoup its investment and realize profits from the
commercial exploitation of Promises only after the payment of (1) Orion's
distribution fees and expenses, (2) the principal and interest of various
indebtedness, and (3) profit participations to such third parties as Marsha
Mason and Jerome Hellman, it was, according to Triad's private offering
memorandum, "anticipated that the [limited partners of Triad] will not recoup
their investment in [Triad] unless and until Gross Receipts [from the
commercial exploitation of Promises ] equal at least $27,000,000."

17

Promises, which was released on November 2, 1979, was not commercially

successful, although it was accorded some favorable critical reviews; its
receipts totaled only $6,273,383 as of June 30, 1987. Ultimately, Triad sold
Promises back to Orion in 1987 for $225,000 and cancellation of the unpaid

balance of the Recourse and Nonrecourse Notes.6

18

On its 1979 federal income tax return, Triad reported income in the amount of
$4,959 and deductions in the amount of $3,612,856, resulting in an ordinary
loss of $3,607,897. Jacobson deducted a distributive share of this loss, $57,125,
on the 1979 federal income tax return at issue in this litigation. He also took an
investment tax credit in the amount of $3,198 as his distributive share of Triad's
1979 investment tax credit of $202,000.

19

In a statutory notice of deficiency dated May 30, 1985, the Commissioner

disallowed the deduction and credit, asserting that the acquisition of Promises
was not an activity entered into for profit under section 183(a). The
Commissioner also disallowed, duplicatively, certain components of the
partnership loss: i.e., deductions for depreciation, tax advice, advertising-marketing, distribution fees, interest expense and other expenses. The
Commissioner further determined that the resulting underpayment was a
substantial underpayment attributable to a tax motivated transaction under
section 6621(d), resulting in a penalty interest rate on the underpayment of
120% of the normal rate imposed by section 6621.

20

Jacobson filed a timely petition for redetermination of the asserted deficiency in

the Tax Court. Jacobson maintained that (1) the Triad loss of $3,607,897 for
1979 resulted from legitimate deductions for depreciation and for ordinary and
necessary business expenses, (2) Triad's investment tax credit of $202,000 for
1979 was similarly legitimate, and (3) Jacobson's adjusted basis in his
partnership interest in Triad equaled or exceeded $57,125; and that the
disallowance of Jacobson's loss deduction and investment tax credit were
accordingly improper.

21

In an amended answer to Jacobson's petition, the Commissioner alleged, inter

alia, as additional grounds in support of the asserted deficiency, that Triad did
not have sufficient benefits and burdens of ownership in Promises to entitle the
partnership to the tax benefits of ownership of the film, that Triad's payment
for Promises unreasonably exceeded the film's fair market value, and that the
obligation represented by the Recourse Note was speculative and contingent.

22

The Tax Court upheld the Commissioner. In doing so, the court made, inter
alia, the following "findings of fact":

23 film is a slow-paced melodrama, and the screen play is full of trivial

The
conversation and shallow commentary. The subplots (the doctor's relationship with a

male radiologist and the patient's relationships with her parents and boyfriend) are
pedestrian, and the supporting characters are flat.
24

55 T.C.M. at 1437.
The court later elaborated, stating:

25
Considering
the film's trivial and shallow screenplay, its depressing and downbeat
theme without offsetting character development, and its slow pace, Promises was
discernibly not going to be a "blockbuster." We concur with respondent's expert that
it was manifestly impossible for the film to generate gross receipts of $27,000,000.
26

Id. at 1443.
The court continued in the same vein:

27 the benefit of seeing the finished product and with all of their experience in the
With
movie industry, Glass and Malamed could not have reasonably believed that
Promises would be a profitable film.
28

Our conclusion is based substantially on the testimony of respondent's expert

William A. Madden which was confirmed by our viewing of the film. Based on
the film's slowly paced, morbid story line, the mediocre performance of the cast
(aside from Marsha Mason), the failure to develop the characters, and the lack
of success of prior films on cancer and euthanasia, we agree with Madden's
conclusion that Promises had no domestic or foreign theatrical value. He stated
that the picture's gross receipts would not exceed its high cost of marketing and
distribution. The quality and subject matter of Promises and the high cost of
marketing and distribution of the film, combined with the fact that Triad
acquired relatively few valuable rights in Promises pursuant to the Purchase and
Distribution Agreements lead us to the conclusion that there was no realistic
possibility that petitioners would receive back their investment in Triad (aside
from tax benefits).

29

Id. at 1444.
The Tax Court concluded:

30 transaction at issue was a mere paper chase compelled by tax avoidance

The
features rather than by business realities. Apart from Federal income tax benefits the
transaction entered into by petitioner had no realistic potential for profit.

Consequently, we hold that the transaction at issue is devoid of economic substance

and should be ignored for Federal income tax purposes.
31

Id. at 1445.

32

The Tax Court also ruled that Jacobson's distributive share of certain interest
and commitment fees paid by Triad with respect to the Marketing Loan were
not deductible because Orion was the true obligor thereon, but that interest and
commitment fees attributable to the Additional Financing Loan were properly
deductible pursuant to section 163(a). Id.; see supra note 3. Finally, the Tax
Court sustained the Commissioner's determination that the resulting deficiency
constituted a substantial underpayment of tax attributable to a tax motivated
transaction for which a penalty interest rate under section 6621(d) should be
assessed. Id.

33

This appeal followed.

Discussion
34

The primary issue which we must consider on this appeal is whether the Tax
Court correctly determined that the transaction at issue was "devoid of
economic substance and should be ignored for Federal income tax purposes."
55 T.C.M. at 1445. We reverse this determination, and remand for
reconsideration of Jacobson's liability for federal income tax in 1979, as
hereinafter specified.

A. The "Economic Substance" of the Acquisition of Promises.

35
36

While the Tax Court's conclusion that the acquisition of Promises lacked
economic substance is a finding of fact to be reviewed for clear error, the legal
standard applied by the Tax Court in making this determination is reviewed de
novo. See Sochin v. Commissioner, 843 F.2d 351, 353 (9th Cir.), cert. denied,
488 U.S. 824, 109 S.Ct. 72, 102 L.Ed.2d 49 (1988); see also Bailey v.
Commissioner, 912 F.2d 44, 47 (2d Cir.1990); American Realty Trust v. United
States, 498 F.2d 1194, 1198 (4th Cir.1974).

37

The question whether a transaction is devoid of economic substance is often

analyzed in terms of its being "sham." A sham transaction analysis requires a
determination "whether the transaction has any practicable economic effects
other than the creation of income tax losses." Rose v. Commissioner, 868 F.2d
851, 853 (6th Cir.1989); see Sochin, 843 F.2d at 354. "A transaction is a sham

if it is fictitious or if it has no business purpose or economic effect other than

the creation of tax deductions." DeMartino v. Commissioner, 862 F.2d 400, 406
(2d Cir.1988).
38

Such cases are also considered in terms of the section 183(a) provision that
where an "activity is not engaged in for profit, no deduction attributable to such
activity shall be allowed under this chapter" except to the limited extent
specified in section 183(b). In Smith v. Commissioner, 91 T.C. 733 (1988), the
Tax Court explained the interplay between an "economic substance" analysis
and the mandates of section 183 as follows:

Profit Objective and Economic Substance

39

Determination of whether an activity is undertaken for profit is generally

referred to as involving a "section 183 issue." Section 183 initially served to
distinguish between business objectives and personal objectives, but in recent
years has been used frequently to compare business objectives with tax
objectives. See generally Brannen v. Commissioner, 78 T.C. 471, 506-07
(1982), aff'd. 722 F.2d 695 (11th Cir.1984); Jasionowski v. Commissioner, 66
T.C. 312, 321 (1976). In Rose v. Commissioner, 88 T.C. 386, 414 (1987),
[aff'd, 868 F.2d 851 (6th Cir.1989),] we adopted a unified test of economic
substance incorporating factors considered relevant in cases decided under
section 183. The Rose approach was a restatement of prior law, particularly
identifying objective factors examined under various theories by which [the
Commissioner commonly] challenges the tax treatment of transactions.
"Reliance on these objective factors enables us to focus our scrutiny on the
actual mechanics of the transactions, rather than on an ephemeral analysis of
subjective intentions." Rybak v. Commissioner, 91 T.C. 524, 535 (1988).

40

91 T.C. at 753-54.

41

In any event, whether the terminology employed is that of economic substance,

sham, or section 183 profit motivation, we regard the methodology used by the
Tax Court in the instant case as fundamentally flawed, and setting a dangerous
precedent. Approximately one movie in ten is a commercial success. See
Cherin v. Commissioner, 89 T.C. 986, 993 (1987) (citing Abramson v.
Commissioner, 86 T.C. 360, 369 (1986)). The regulations issued by the Internal
Revenue Service under section 183 recognize, however, that risky activities of
this nature may nonetheless be pursued in anticipation of profit, stating:

42 determination whether an activity is engaged in for profit is to be made by

The
reference to objective standards, taking into account all of the facts and

circumstances of each case. Although a reasonable expectation of profit is not

required, the facts and circumstances must indicate that the taxpayer entered into the
activity, or continued the activity, with the objective of making a profit. In
determining whether such an objective exists, it may be sufficient that there is a
small chance of making a large profit. Thus it may be found that an investor in a
wildcat oil well who incurs very substantial expenditures is in the venture for profit
even though the expectation of a profit might be considered unreasonable. In
determining whether an activity is engaged in for profit, greater weight is given to
objective facts than to the taxpayer's mere statement of his intent.
43

26 C.F.R. Sec. 1.183-2(a) (1990) (emphasis added).

44

The Tax Court has frequently addressed the bona fides of movie transactions in
terms of the "objective facts" that were ascertainable at the time the
transactions occurred. In this case, those facts would include the standing and
experience of Triad's general partners, the absence of any collusive relationship
between Triad or its general partners and Orion, the arm's-length negotiations
for the acquisition and distribution of Promises, the reputation and experience
of its leading lady, director and screenwriter, and a purchase price for Promises
that approximated its production cost. See generally Evans v. Commissioner,
908 F.2d 369, 374 (8th Cir.1990); Upham v. Commissioner, 57 T.C.M. (CCH)
508, 512-15 (1989); Brown v. Commissioner, 56 T.C.M. (CCH) 638, 649-51
(1988); Schwartz v. Commissioner, 54 T.C.M. (CCH) 11, 23-29 (1987);
Vandenhoff v. Commissioner, 53 T.C.M. (CCH) 271, 277-81 (1987). As to the
significance of a purchase price that approximates production cost, see Evans,
908 F.2d at 374; Siegel v. Commissioner, 78 T.C. 659, 687-88 (1982); Upham,
57 T.C.M. at 510, 513; Vandenhoff, 53 T.C.M. at 282; cf. Sheid v.
Commissioner, 50 T.C.M. (CCH) 663, 670 (1985) (purchase as a result of
arm's-length bargaining fixes fair market value; appraisal testimony arguably
irrelevant).

45

Interestingly, in Upham, Brown, Schwartz, and Vandenhoff (1) Glass was a

general partner (or, in the case of Schwartz, one of two Class A limited
partners) of the acquiring partnership; (2) the Tax Court considered and
rejected the contention that the acquisition lacked economic substance, was
sham, or was not transacted for profit; but (3) the Tax Court concluded that the
acquiring partnership did not become the owner of the film in question,
although it did acquire a depreciable interest in the gross receipts to be
generated by exploitation of the film "acquired" by the partnership. See also
Bailey v. Commissioner, 912 F.2d 44, 47-48 (2d Cir.1990) (affirming such a
Tax Court determination). Evans involved a purchase of a film by a Glass
partnership from Orion, with many features similar to those presented in the

instant case, see 908 F.2d at 371, and reversed as clearly erroneous a Tax Court
ruling that (1) the activity in question was not engaged in for profit, see section
183(b), and (2) section 6621 penalty interest should be imposed. See Evans v.
Commissioner, 56 T.C.M. (CCH) 335 (1988), rev'd, 908 F.2d 369 (8th
Cir.1990).
46

The primary focus in these and similar Tax Court cases has been upon "the
written agreements and the attendant facts and circumstances." Upham, 57
T.C.M. at 512 (citing cases); accord, Brown, 56 T.C.M. at 649 (citing cases).
Here, on the contrary, the Tax Court set aside such considerations, while
conceding that they "would indicate a reasonable profit potential before
Promises was produced," 55 T.C.M. at 1444. Instead, the court concluded, in
reliance upon its own subjective reaction to the film as produced and the
testimony of a concurring expert witness, that it was "manifestly impossible"
for the film to yield profits to Triad, id. at 1443, and that Triad's general
partners had to realize this after viewing Promises preparatory to its acquisition,
id. at 1444.

47

We reject this judicial version of the Siskel and Ebert "thumbs up, thumbs
down" approach to film evaluation. The dangers and proclivity for abuse of
such hindsight judgments, in so subjective and unpredictable an area of
endeavor with a failure rate of approximately ninety percent, are apparent. We
are not ruling that no weight can be given to a viewing of a completed film
when it is the subject of an acquisition. For example, the Tax Court, as trier of
fact, is entitled to include in its consideration any negative assessment that
might be warranted as to the technical deficiency of a film, such as its
unprofessional production, if such was objectively apparent. But the court is not
to reject profit motive because of subjective dislike of a film's style or
disapproval of a film's theme. It is not for courts to predict what themes are
geared to popular success. A film's depressing theme does not preclude such
success, as numerous epics, including "Camille," attest.

48

Similarly, the Tax Court was entitled to consider, as it did, see id. at 1445, the
reconveyance of Promises to Orion by Triad in 1987. We do determine,
however, that it was error to decide the question of economic substance
primarily on the basis of the court's subjective reaction to the finished film, and
that primary attention must be given to the considerations traditionally
employed by the Tax Court in evaluating movie acquisitions for economic
substance and tax consequences. See Evans, 908 F.2d at 374.

49

In view of this determination, the judgment of the Tax Court must be reversed
and remanded for reconsideration of Jacobson's 1979 tax liability. As in

Upham, Brown, Schwartz, and Vandenhoff, the court should consider the
questions (1) whether there was economic substance to the Promises
acquisition, and if there was, (2) whether Triad acquired an ownership interest
in Promises, or some lesser but nonetheless depreciable interest in the gross
receipts generated by the exploitation of Promises. See also Bailey, 912 F.2d at
47-48.
B. Collateral Matters.
50
51

The Tax Court concluded in its opinion that the Recourse Note was in fact
nonrecourse because the repayment of its principal was assured by television
receipts already in hand from CBS. As the parties agree, see supra note 5, this
conclusion was premised upon a factual error. Accordingly, this matter must be
reconsidered upon remand, bearing in mind that third-party sources of funds do
not necessarily make an obligation nonrecourse for a party who is personally
liable to the obligee. See, e.g., Frank Lyon Co. v. United States, 435 U.S. 561,
576-77, 98 S.Ct. 1291, 1300, 55 L.Ed.2d 550 (1978); Gefen v. Commissioner,
87 T.C. 1471, 1492-93 (1986). But cf. section 465(b)(4) and (c)(1) (disallowing
loss deduction for taxpayers engaged in "holding, producing, or distributing
motion picture films or video tapes" as to "amounts protected against loss
through nonrecourse financing, guarantees, stop loss agreements, or other
similar arrangements").

52

The Tax Court also ruled upon deductions taken by Jacobson for his
proportionate share of interest and commitment fees paid by Triad with respect
to the Marketing Loan and the Additional Financing Loan. These deductions
were available to Jacobson despite the ruling that the Promises acquisition was
a sham transaction. See sections 183(b)(1), 163(a).

53

The Tax Court found that the Additional Finance Loan was a bona fide and
fully recourse indebtedness of Triad for which Triad pledged as security the
letters of credit and certificates of deposit contributed to Triad by the limited
partners evidencing their original capital contributions, see 55 T.C.M. at 1440,
1445, and accordingly allowed Jacobson to deduct his proportionate share of
interest and commitment fees attributable to that loan. In the absence of a crossappeal, no issue is presented to us regarding that ruling.

54

The deduction claimed for interest and commitment fees attributable to the
Marketing Loan, however, was disallowed on the basis that this loan was not a
bona fide indebtedness of Triad. See id. at 1445. Even if the motive for a
transaction is to avoid taxes, interest incurred therein may still be deductible if
it relates to economically substantive indebtedness. Rice's Toyota World, Inc. v.

Commissioner, 752 F.2d 89, 95-96 (4th Cir.1985). Here, the Marketing Debt is
an actual indebtedness owed to Chemical Bank. The question remains,
however, whether Triad's partners are the proper parties to claim the deduction.
55

The Tax Court correctly relied upon Anderson Dairy, Inc. v. Commissioner, 39
T.C. 1027, 1044 (1963), for the proposition that a taxpayer may not deduct
interest paid or incurred on an obligation of another. See Borchert v. United
States, 757 F.2d 209, 211 (8th Cir.1985). The court further determined that the
Marketing Loan was in reality an obligation of the film's distributor, Orion,
rather than a nonrecourse obligation of Triad, as claimed, because the interest
and principal of the loan were payable by Orion to Chemical Bank from the
gross receipts generated by Promises, and any deficiency was also payable by
Orion and treated as a nonrecourse loan to Triad. See 55 T.C.M. at 1445. This
determination was not clearly erroneous, and is therefore affirmed. In doing so,
we reject Jacobson's contention that, because Orion was entitled to recoup
interest payments it made on the Marketing Loan from proceeds generated by
the exploitation of Promises which would otherwise have gone to Triad, Triad
is entitled to deduct those payments. See Pounds v. United States, 372 F.2d
342, 352 (5th Cir.1967).

56

Finally, the Tax Court determined that penalty interest should be imposed
pursuant to section 6621(d) because the acquisition of Promises was "sham"
within the meaning of that section. See 55 T.C.M. at 1445. In view of our
reversal of the Tax Court's basic determination that the transaction lacked
economic substance, the penalty interest ruling must also be reversed.

Conclusion
57

Except as it relates to the deductibility of interest and commitment fees paid

with respect to the Marketing Loan and the Additional Financing Loan, the
decision of the Tax Court is reversed and the case is remanded for further
proceedings not inconsistent with this opinion.

Marcia Jacobson is a party because she filed a joint federal income tax return
with her spouse Harvey Jacobson ("Jacobson") for 1979

Statutory references hereinafter are to the Internal Revenue Code of 1954 (26
U.S.C.) as amended and in effect during 1979. The Code has since been
redesignated as the Internal Revenue Code of 1986. See Tax Reform Act of
1986, Pub.L. No. 99-514, Sec. 2, 100 Stat. 2085, 2095

The Commissioner's notice of deficiency specified a deficiency of $29,654. The

order and decision of the Tax Court from which this appeal is taken determined
a deficiency of $29,444. This variation apparently resulted from the Tax Court's
determination that Jacobson was entitled to deduct his distributive share of
certain interest and commitment fees attributable to an Additional Financing
Loan hereinafter described, pursuant to section 163(a). See 55 T.C.M. at 1445

Orion excluded the following rights in Promises from the sale to Triad: rights in
literary, dramatic or musical material (except to the extent necessary to
distribute Promises throughout the universe); television series, special, remake
or sequel rights; theatrical stage rights; the right to enter into agreements with
respect to Promises; and option rights with respect to persons rendering services
in the production of Promises

At the time the Purchase Agreement and Distribution Agreement were

executed, Orion had a contract with CBS calling for a license fee of $3,500,000
for two network broadcasts of Promises. The Tax Court erroneously found that
CBS had paid this amount to Orion prior to execution of these agreements,
thereby concluding that since "[t]his amount, after deduction of 25 percent
distribution fee, substantially covered the principal balance of the [Recourse]
Note," the Recourse Note was in fact nonrecourse. See 55 T.C.M. at 1438. On
appeal, Jacobson contends that the Tax Court's factual error, together with
various contractual contingencies relating to the CBS payment, require reversal
of the Tax Court's ruling that the Recourse Note was in fact nonrecourse. The
Commissioner contends that the Tax Court ruling should be upheld because the
CBS payment was to be made before the principal balance of the Recourse
Note became payable, and the contractual contingencies regarding that payment
were insubstantial

The Tax Court opinion incorrectly stated that the amount of the cash payment
was $285,000. See 55 T.C.M. at 1442